Where can I invest my cash to earn some level of return?

Where can I invest my cash to earn some level of return?

April 28, 2022

A common question that arises during client reviews is, “I have cash on hand. Are there any options where I can earn some level of return given that I am earning next to nothing in my savings account?” U.S. Treasury Series I bonds (“I bonds”), with current annualized returns of 7.12%, can be a great compliment to a portfolio.

I bonds are savings bonds issued by the U.S. government that are intended to provide inflationary protection to investors. Specifically, I bonds earn interest through a combination of two rates: (1) a fixed rate, which remains constant throughout the 30-year bond term; and (2) a variable rate, adjusted twice annually, based on the non-seasonally adjusted Consumer Price Index for all Urban Consumers (“CPI-U”) for all items, including food and energy. Currently, the fixed rate for I bonds is 0%.[1] However, given recent inflationary movements, the variable rate is 7.12% as of April 26, 2022, thereby yielding a composite return of 7.12%.[2]

The variable rate is established every May and November and is guaranteed for the following six months. However, the change is applied to bonds every six months from the date of issuance, which may not be May 1st and/or November 1st. Interest is earned monthly and compounded semiannually. From a calculation standpoint, interest earned every six months is added to the bond’s principal value based on the issuance date. Thereafter, interest for the following six months is determined based on the new principal amount.

With yields of 7.12%, I bond returns far outpace the one-year U.S. Treasury Bill at 1.99% and the one-year CD rates offered from Marcus by Goldman Sachs at 1.2%, both as of April 26, 2022. Given the discrepancy in returns for a relatively similar risk profile, why isn’t everyone rushing to I bonds? There are a few catches.

  • Only $10,000 of I bonds can be purchased per person per year with the option to purchase an additional $5,000 annually funded through a tax refund.[3]
  • I bonds must be held for at least one year. Therefore, savings reserved for ultra-short-term needs should not be contributed to I bond purchases.
  • I bonds must be purchased directly through the Treasury Direct website at treasurydirect.gov. Advisors are not able to purchase I bonds on behalf of investors and bonds cannot be purchased within retail brokerage accounts or retirement accounts. The Treasury Direct website is clunky. However, individual investors can establish an account and transfer funds after providing simple account and routing number information. Given that the government tracks ownership via Social Security number, it is imperative for individuals to share relevant password and updated purchase information with loved ones in the event of a catastrophic incident.

I bonds offer strong inflationary protection for low risk. Given that I bonds cannot be traded on a secondary market, the redemption value of I bonds cannot decline. Further, the interest earned can never be less than zero. As noted previously, I bonds must be held for at least one year. I bonds, however, may be cashed in at any time thereafter up until the expiration of the 30-year term. If an I bond is redeemed before five years from issuance, interest is forfeited for the prior three months. No penalty exists for I bonds redeemed after five years.

In a worst-case scenario, assume I bonds earn 7.12% for the next six months. Then assume inflation decreases to 0%. If these I bonds were redeemed after one year, an investor would still earn 3.56% for the year, even after losing the last three months of interest. It should be noted that I bonds are estimated to yield a 9.62% annualized return beginning May 1, 2022. Therefore, this “worst-case scenario” is highly hypothetical.

From a tax perspective, interest earned is subject to federal income tax, but not state or local income taxes. When determining how to report interest for federal income taxes, investors have two options: (1) report interest every year; or (2) defer reporting interest until the bond is either cashed in and/or reaches final maturity.

For investors with excess cash that is not immediately needed over the next twelve months, an investment in I bonds is likely a great opportunity even despite the added aggravation of utilizing the outdated Treasury Direct website. It is not often that low risk investing vehicles offered by the U.S. government yield returns competitive to those earned in the equity and crypto markets.[4]

[1] The Treasury announces the fixed rate for I bonds every six months in May and November. The fixed rate is an annual rate.
[2] The composite rate calculation as of April 26, 2022 is as follows: Composite rate = [fixed rate + (2 * semiannual inflation rate) + (fixed rate * semiannual inflation rate)] = [0 + 2 * 0.0356) + (0 * 0.0356)] = 7.12% composite rate.
[3] Minimum purchase amount is $25. Bonds can be purchased in any increment between $25 and $10,000 annually to the penny.
[4] As of 4/25/2022 market close the YTD return on the S&P 500 is -9.9%. The YTD returns for Bitcoin and Ethereum as of the same date are -14.6% and -21.0% respectively.